US Bank bailout watchdog warns of commercial real estate crisis

Friday, February 12, 2010, 08:02

The commercial real estate market has fallen more than 40% from early 2007 and a wave of loan failures in the next few years could threaten the economy just as it struggles back to its feet, a report from the panel overseeing the $700 billion bank bailout said.

“A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American,” said the report, released on Thursday.

Elizabeth Warren, a Harvard Law School professor who chairs the five-member Congressional Oversight Panel, told reporters on a conference call that the report did not endorse specific policy recommendations because members were split.

“The panel is clear that government cannot and should not keep every bank afloat,” the report said. “But neither should it turn a blind eye to the dangers of unnecessary bank failures and their impact on communities.”

Asked to clarify, Warren suggested to reporters that the government could allow some banks to fail while closely watching the situation, and could step in if the pace of failures became too rapid.

The panel “is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation's mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy,” the report said.

Warren said there are about $1.4 trillion worth of outstanding commercial real estate loans in the United States that will need to be refinanced before 2014, and about half of them are already “underwater,” an industry term that refers to loans with a higher amount than the property's current value.

Unlike residential loans, which are frequently amortized over three decades, commercial real estate loans are usually made with 3- to 5-year terms and include a balloon payment at the end of the term. In normal circumstances, these loans are refinanced before the term ends.

“Without new financing, the properties face foreclosure, banks face insolvency, and the customers, businesses and renters in those properties face a great deal of uncertainty,” Warren said.

The report outlined six tools that could be used “to relieve some of the pressure” in commercial real estate and allow for refinancing, including injecting capital into the troubled banks and purchasing bad loans. The report also suggested the government could establish a guarantee fund for some financial firms and work to improve access to credit for small businesses.

The report said the largest losses are scheduled to begin next year and could range as high as $200 billion to $300 billion. (Reuters)

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